Retrospective tax was indefensible; burying it shows pragmatism

Institutional arrogance in taxation has cost India dearly in terms of its image as a business-friendly, rule-driven country

I distinctly remember the union budget in which Pranab Mukherjee, as Finance Minister, sneakily introduced the retrospective tax. I was at a post- budget panel and as usual for all budgets the entire panel, including me, were busy giving 11 marks out of 10. That was until somebody whispered into our ears that in the fine print, there was a clause bringing in a retrospective tax amendment to ensnare Vodafone.

Obviously, the budget marks went down sharply to 10/10: a full mark was deducted by the panel for this horrendous decision.

After that, a whole saga ensued in which the entire tax mechanism and the Finance Minister went all out to defend the indefensible. The trend continued even after governments changed and proclaimed there would be no tax terrorism.

Before that, I remember when the Bombay High Court's Income Tax bench ruled against Vodafone, which had appealed against the income tax department's first order on tax levied on something called "indirect transfer"! I was astounded. It was as if the shares of a company could be directly linked to some of its assets.

Vodafone appealed and the Supreme Court did the right thing by setting aside the order of the Bombay High Court. This then led to the infamous retrospective tax amendment.

A point is often missed in this entire imbroglio: capital gains tax are levied on the person receiving the capital gains and not on the person paying out the capital gains. This point should be obvious to everybody. The bizarre thing is that Vodafone was the buyer and Hutch was the seller of the shares of the overseas company, which held the local Indian company. The capital gains had accrued to Hutch, and not to Vodafone.

So, how on Earth were India’s revenue authorities demanding capital gains tax from the buyer and not from the seller? That is because the seller had taken the money and was sitting happily in Hong Kong, so the authorities did the next best thing: they got hold of the buyer and said that if the seller has not paid that automatically means that the buyer must pay! Go and figure that out.

This case smacks of the ITC Excise litigation of the eighties. ITC won the dispute at the Supreme Court level but again a retrospective amendment was made in order to make the company pay.

An enduring characteristic of Indian policy makers is that they continue defending the indefensible and never ever admit that something wrong was done. You will find appeal after appeal, year after year on the exact same settled tax matters merely because authorities cannot admit that they were wrong. I have come across the term "We need a face saving way out of this" several times in my conversations with various authorities over years.

This institutional arrogance has cost India dearly in terms of its image as a business-friendly, rule-driven country.

This entire sordid affair is a reminder to everybody in India who are in the self-congratulatory mode after China changed rules for its various technology companies: we are no better when it comes to arbitrary rules and laws.

Let us hope that we as a nation put rule of law above everything, and that the lawmakers should not themselves become lawbreakers by making a mockery of laws.

I am delighted that this sorry chapter of the retrospective tax has been put to rest by the Modi government. This shows pragmatism, and let us hope that we will not get such capricious amendments in the future ever.

(Shankar Sharma is the cofounder of First Global, a global Investech-Asset Management Company. Views expressed in this article are his own.)